Institutional EYE

Commentary on Corporate Governance Issues

Royalty has been a contentious issue for MNCs set up in India. In FY15, 32 MNCs paid out an aggregate Rs. 63 bn, which was almost 21% of their pre-royalty pre-tax profits – a growth of 10% over FY14 levels. MNCs based in India pay royalty because they use brands/technology know-how that have been developed outside India by their global parents and are a result of extensive product research and knowledge. Therefore, royalty is a legitimate payout – but, how much is the right amount?

Graphic: Business Standard

Our study of the 32 MNCs in the BSE 500 shows that over the past five years, aggregate royalty and related payments for these MNCs increased at a five-year CAGR of ~20% compared to a mere ~7% growth in their pre-royalty pre-tax profits. The steady increase in royalty payouts can be largely attributed to a change in regulations in December 2009, which liberalized the payment of foreign technology collaborations and royalty fees under the automatic route (including lump sum payments for transfer of technology, payments for the use of trademark and brand name).

To assess the appropriateness of royalty payouts, IiAS has developed the “IiAS Royalty Signal”. The model assesses the appropriateness of royalty payout levels and includes measuring royalty payouts in context of revenues, margins and dividend. Based on the overall score, companies are categorised into three buckets: green, amber and red. We first looked at royalty payments in December 2012 and introduced the royalty signal in 2013 (based on FY13 financial statements). Our updated analysis (based on FY15 financials), shows:

The BSE 200 companies have reported better growth and margins than these 32 MNCs in FY15.

Disproportionate increase in royalty (5 year CAGR) compared to revenues/profits/dividends has led Akzo Nobel, Alstom India and SKF India moving to red bucket (amber last year) and Cummins India to amber (green last year).

FAG Bearings and Bosch have improved on their position to amber (red last year) owing higher growth in sales viz-a-viz royalty.

Timken India has moved to green (amber last year) as performance outpaced the growth in royalties in FY15.

Snapshot of IiAS royalty signal:

Although royalty to the global parent is a related party transaction, under current regulations, such transactions do not need shareholder approval. In order to push companies to explain the basis of their charging royalty and be more considered in their royalty payouts, IiAS believes these payments must be brought under the ambit of shareholder approval. Until then, investors must engage with MNCs in India and actively push them to rationalize royalty payouts.

You can read our full report ‘Royalty continues to outpace profits; shareholders must demand a greater say’ here.